Detroit Takes the Municipal Bankruptcy Plunge

Jul 19, 2013 | Municipal Bankruptcy, Municipal Finance

Updated July 23, 2013 – Detroit has been known for many things over the years … cars, music, and now municipal bankruptcy.  On July 18, the City of Detroit became the largest city to file for Chapter 9 municipal bankruptcy protection.

James Spiotto, a bankruptcy attorney and partner at Chicago-based Chapman & Cutler, points out that Detroit is – by population and amount of debt – the largest Chapter 9 filing in U.S. history.  “It is also unique in that never before has the largest city in any state ever filed for Chapter 9,” he says. 

… the filing of a bankruptcy does not stop the provision of essential government services.

“Up until now, the largest city of any state, when faced with financial difficulties, has found a way to work with the state to solve its problems.  That was the case with New York City in 1975, Cleveland in 1978, and Philadelphia in 1991.”

What a Municipal Bankruptcy Filing Really Means

It is important to note that the filing of a bankruptcy does not stop the provision of essential government services, Spiotto explains.  The Chapter 9 proceeding merely deals with the municipal debt adjustment.  The Bankruptcy Court does not have jurisdiction over the government, politics, and affairs of the City.

He also clarifies that, in most cases, municipal bankruptcy results in debt adjustment – not elimination. 

Here’s how it works:  Detroit will eventually propose a Chapter 9 plan of debt adjustment, which will be presented with a disclosure statement setting forth all relevant facts about its feasibility and the treatment of claims.  The Bankruptcy Court will hold hearings on the disclosure statement and the plan, which will be presented to the creditors for a vote.  It takes one class of creditors voting 50 percent in number of that voting class and two-thirds of the debt amount in that class to be an accepting class.  One accepting class is required in order for the Bankruptcy Court to hear the confirmation of the plan.

In most cases, municipal bankruptcy results in debt adjustment – not elimination.

All of this takes time.  If creditors raise objections to filing, according to Spiotto, “it could take a number of months – possibly even a year – before the Bankruptcy Court determines whether the filing by Detroit meets the requirement for filing.”

In the recent filing of Stockton, California, which filed in June 2012, it took almost a year before the court determined the issues and questions relating to a “good faith” filing, and whether it met the criteria.

While Detroit’s Emergency Manager may contend that the proposal which he set forth can help pre-package or accelerate the bankruptcy process, there are obviously going to be issues with various creditor constituencies, including how secured debt will be treated and paid, how the unlimited tax GO’s which had been voter approved will be treated, what are the rights of the workers and the retirees to payment, can unfunded pension liability be adjusted in a Chapter 9?  Every issue will have to be heard.  Chapter 9 is generally measured by years, especially in complicated, large cases, Spiotto says. 

Municipal Bankruptcy Remains Rare

Despite a string of fiscally strapped municipalities whose names – Stockton, Harrisburg, San Bernardino, and Jefferson County – have made it to mainstream news headlines over the past year, municipal bankruptcy remains rare.  “Bankruptcy is time-consuming, expensive, and non-user friendly,” he says. 

Spiotto says that any financially struggling municipality knows that it will someday have to return to the municipal market – and no municipality wants to risk market access or prohibitive borrowing costs that come as a consequence of bankruptcy.

Since 1937, there have been 647 Chapter 9 municipal bankruptcy filings.  There have been only 61 Chapter 9 filings for cities, towns, villages and counties since 1954 – of these, 29 never reached a confirmed plan of debt adjustment because they found other ways to address their financial problems.

Prior to Detroit’s filing, Stockton was the largest U.S. city to file for Chapter 9 municipal bankruptcy protection.

In Spiotto’s words, “We are slow to say we are seeing any trend here.  Bearing in mind that there are over 80,000 municipal entities in the U.S., it is almost surprising that we don’t see it more often.”

The Road to Recovery is Paved with Economic Revitalization

“Debt adjustment and the filing of a Chapter 9 is only part of a process – not a solution,” Spiotto says.  “While citizens, creditors and taxpayers should not panic, it is important for the City to develop a recovery plan that will stimulate the economy by attracting new businesses and increasing its population.”  Creating more job opportunities, a more educated workforce, and increasing the quality of its infrastructure – including schools – will all help increase the appeal of Detroit as a place to live and work. 

“A recovery plan that stimulates the City’s economy will increase the number of taxpayers contributing to its revenues – revenues on which a successful city relies to thrive."

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